Stock in Globex Corporation has a beta of 0.9. The expected market return is 10%, and T-bills are currently yielding 3.5%. The company's next dividend is expected to be $2 per share, and dividends have been growing at a 4% annual rate. If the stock sells for $25 per share, what is your best estimate of the company's cost of equity?

Question

Quizplus · Accepted Answer

The cost of equity can be estimated using the Capital Asset Pricing Model (CAPM): Cost of Equity = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Substituting the given values: 3.5% + 0.9 * (10% - 3.5%) = 9.77%. However, the Dividend Discount Model (DDM) can also be used: Cost of Equity = (Dividend/Price) + Growth Rate = ($2/$25) + 4% = 12%. The average of these two estimates is approximately 10.68%.

Stock in Globex Corporation Has a Beta of 0